Stock analysis is confusing, but it doesn’t have to be. There are 12 things to consider before you buy a stock. Let me break them down for you.
1. Quick Ratio Current assets ÷ current liabilities = Quick Ratio This tells you if a company has enough assets to pay upcoming debts. A quick ratio of 1 is normal. In general, you want a quick ratio above 1.
2. Net profit margin (NPM) Net income ÷ Revenue = NPM This shows you how much money a company makes for every dollar in sales. This helps you assess if a company is profiting from sales and if operating/overhead costs are contained. Ideally, this number should grow over time.
3. Return on assets (ROA) Net income ÷ Total assets = ROA This shows how much money a company makes relative to its total assets. Or how efficiently a company uses its resources to generate profits. The ROA depends on the industry/ direct competitors.
4. Earnings per share (EPS) Profit ÷ outstanding shares = EPS This is how much money a company makes for each share of stock. A higher EPS indicates a valuable company. This is especially important when comparing against companies in the same industry.
5. Price-to-earnings ratio Share price ÷ EPS = P/E ratio This tells you how much a company is worth. And how much investors will pay per share for $1 of earnings. A high P/E means over-bought or bullish investors. A low P/E means oversold or bearish investors.
6. Price to sales ratio (PSR) Market cap ÷ Annual sales = PSR In general, the lower the P/S ratio, the more attractive the investment. This ratio is beneficial for growth stocks that have no profits or have experienced a short-term setback.
7. Enterprise multiple Enterprise value ÷ EBITDA = Enterprise multiple This is how a company would be viewed before a potential acquisition. It’s basically a valuation that considers a company’s debt. A good or bad enterprise multiple varies from industry to industry.
8. Moat Moat is a company’s competitive edge in the market. What makes the company better than its competitors? - Is it cheap production costs? - Patented technology? - Size advantage? Having an economic moat is a good sign.
9. Future growth What are the company’s growth prospects? Is the industry in a decline? Are they in a new industry? Do they plan to move to a new market? These are important considerations when evaluating a company. You want a company with good future growth prospects.
10. Lawsuits Lawsuits aren’t always detrimental to a company, but sometimes they have a negative impact. Specifically, lawsuits that make headlines. Pay attention to how management and financial analysts react.
11. Management Good companies can die under poor management. Poor companies can thrive under great management. Research the backgrounds of company executives to determine their competency. Also pay attention to their plans for the future.
12. Consumer Sentiment Financials aren’t the only things that matter. How do real people feel about the company? And what implications does this have for earnings? Focus on what consumers say, and how they use the products. After all, consumers are how companies profit.
TL;DR: When analyzing a stock, you should know: 1. Quick Ratio 2. Net profit margin 3. Return on assets 4. Earnings per share 5. Price-to-earnings ratio 6. Price to sales ratio 7. Enterprise multiple 8. Moat 9. Future growth 10. Lawsuits 11. Management 12. Consumer sentiment
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